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Strategy forNew Zealand

Dairy Farming2009/2020

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Heading

3

Table of Contents

Executive Summary 4

1. Introduction 8

2. Industry Context 9

3. Industry Outcomes 14

4. Farming Systems Approach 15

5. Industry Strategies 17

6. Measures o Success 24

Appendix: External Scan Update 25

1. Introduction 27

2. Internal Competitiveness 29

3. Imperatives or Productivity Improvement 31

4. Emergence o New Imperatives or Dairy Farming 37

5. Complexity and Diversity on the Farm 39

6. Overview o Past Progress 42

The Strategy or New Zealand Dairy Farming sets the direction or the nextdecade and will guide industry action. It has been led by DairyNZ with theinvolvement o DCANZ (the Dairy Companies Association o New Zealand)and Federated Farmers and is the result o consultation with thousands o

armers and many other stakeholders over the last 14 months.

April 2009

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The key outcomes and measures osuccessThe Strategy has ve key outcomes that refect theoperating environment. Achieving these outcomeswill secure the uture contribution o dairy arming toindividual armers and New Zealand society. Eachoutcome has an associated measure which DairyNZ willreport against.

The Strategy de nes measures o success or all veoutcomes, both in terms o the industry targets (whatsuccess will look like) and how the industry willmeasure it.

Outcome 1

Increasing arm proftability: Pro t rom productivityincreases by $110/ha/yr.

Outcome 2

Talented and skilled people are attracted to, andretained by, the industry: All dairy businesses reportthat their demands or talented and skilled peopleare being met by the labour market and throughpro essional services.

Outcome 3

An internationally competitive milk supply maximisesreturns to armers: Milk is produced at a competitivecost, quantity and quality in relation to other countriesand protein sources. The processing industry uses thiscompetitive milk supply to extract greater value out othe market or armers.

Outcome 4

Industry reputation enhanced locally and globally:The public regard the dairy industry as a good placeto work and as producing a quality product throughstewardship o land and water resources. Dairying isvalued as economically important to New Zealand andaccess to international markets is enhanced.

Outcome 5

Achievement o shared goals through genuinepartnership between industry and governmentand the wider community: The dairy industry andgovernment success ully negotiate and implementsolutions that consider their shared goals and the widercommunitys aspirations. These solutions will grow

arm pro tability, enhance the reputation o the industryboth locally and internationally, build a competitive milksupply, attract talented people and address priorityissues, or example greenhouse gases, water quality,energy and water use.

Executive Summary

It has been developed by and or the dairy industry, andconsiders two key questions. First, what will increasethe pro tability, sustainability and competitiveness oNew Zealand dairy armers? Second, how will dairy

armers arm in the uture? DairyNZ, the industrygood body unded by New Zealand dairy armers,has led the development in partnership with industrystakeholders and is the custodian o the strategy. TheStrategys desired outcomes will only be achieved byall stakeholders working together and this Strategy hasreceived key input rom the dairy processing companies(through the Dairy Companies Association o NewZealand) and Federated Farmers.

The New Zealand dairy industry is predominantlyan export business, with less than ve per cent oproduction consumed domestically. It is the worldslargest exporter o dairy ingredients, accounting ormore than a third o the traded market. The needto compete against low cost producers in a volatileinternational market means that New Zealands dairy

armers must remain ocused on resilient armingsystems with relatively low xed costs. The importanceo the international market means dairy arming in NewZealand must always be considered in the wider globalcontext, taking into account public perception andinternational infuences.

The uni ying theme o the Strategy is the recognitiono the need or a arming systems approach to dairy

arming to achieve the industrys desired outcomes. Aarming systems approach integrates arm production

and resource use with the arm business and its people,all in the context o the environment in which the

arm operates. That is, taking into consideration thedesire o the industry to show stewardship and socialresponsibility, consumer pre erences and trade issues,interdependence with the New Zealand public, andgovernments aims and regulations.

Changes in the operating environmentThe industry has changed signi cantly since 2004,when the Framework was rst developed. A detailedexplanation o the main changes in context is containedin the External Scan (Appendix 1). They can besummarised as:

Global supply and demand balance or dairy1.products avours producers.

Erosion o New Zealands low-cost competitiveness2.poses a threat.

Imperatives or productivity remain.3.

The dairy industry makes a large and growing4.contribution to the New Zealand economy.

The pro tability and value o dairy arm businesses5.has grown strongly.

Public perceptions about the dairy industry6.are mixed.

Public and consumers are driving new sustainability7.imperatives or dairy arming.

Skilled people are increasingly important both8.on- arm and in the industry.

A uni ed approach to innovation and adoption9.is needed.

The Strategy or New Zealand Dairy Farming h as been developed to guide the investment and activities o the

industry rom now (2009) until 2020. It updates and replaces the Strategic Framework or New Zealands Dairy

Farming Future, and has a substantially di erent approach.

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Consumers and trade

Work closely with central government to ensure

access o dairy productions to all markets.

Grow the supply base and logistics or current

specialty milks to satis y market demand.

Achieve gains in milk value throughout the

processing and marketing chain.

Position the quality and sa ety o New Zealand

milk as world-leading, and ensure the industry isprotected against signi cant exotic pestsand diseases.

Governments & regulations

Ensure all plans and policies developed by central

and local government a ecting dairy arming arebased on sound scienti c, economic and socialprinciples.

Deliver tools and practices capable o signi cantly

reducing o - arm losses o nitrogen, phosphorusand greenhouse gases and signi cantly increasingwater use e ciency.

Work with dairy armers to meet all requirements

and negotiated agreements with local andnational government.

Stewardship and social responsibility

Promote and support research, arming practices

and activities that instill pride in dairy arming,advance people and society, and rein orceresponsible land use.

Industry strategiesThe industrys strategies to achieve these outcomes

all into our key areas. A critical part o the industryswork is to identi y, develop and protect essentialcapabilities, assets and resources required or theindustrys uture good.

1. Farming systems design and adaptation

Generate new options rom research and

development in universities, research teams, on-arm innovation and agri-business and integrate intoarming systems with re erence to overall system

per ormance and regional variation.

Achieve armer adaptation, leading to higher

per orming arming systems through e ectiveadoption approaches and building capability in allparts o the industry.

Test government policy initiatives in a arming

system context, and communicate these resultsback to government to infuence policy design.

2. Farmer product system and resource use

Invest in developing new technologies to increase

potential milksolids production rom orage, potentialeed conversion e ciency, cow unctionality and

resource use e ciency.

Develop and enhance the existing animal evaluation

system and a new industry-endorsed, quantitativeplant evaluation system.

Ensure the long-term potential o arm production

to deliver, through achieving a regulatory regimethat supports the agreed use o new plant andanimal material based on both conventional andbiotechnology-based breeding.

3. Farm management systems

Achieve gains in milk value through highest quality

on- arm storage and management o milk and alsopositive changes to milk composition and value romon- arm modi cation.

Dairy business

Ensure dairy business managers have the nancial

and business skills to evaluate di erent options toachieve their desired goals. Provide in ormation thatsupports improved decisions, together with the toolsand processes that enhance arm managementskills development.

Dairy people

Support the long-term success o the dairy industry

by attracting and retaining talented people andgrowing these individuals. Developing a qualitywork environment on- arm will underpin success.

4. Industry sustainability

Within New Zealand, large-scale issues such asgreenhouse gas emissions, catchment managementand water/energy supply a ect the industryssustainability, and require many organisations to aligntheir actions to achieve success.

Achieve industry sustainability through success ul

interaction with central and local governments onregulation and trade issues, ongoing con denceo international customers in the quality oNew Zealand milk and support rom theNew Zealand public.

New Zealand public

Ensure the dairy industry is highly regarded or

its contribution to national wealth, employmentopportunities and career satis action. Promote

armer achievements in producing quality products,resource stewardship, environmental sustainabilityand animal wel are.

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1. Introduction

In 2004, the dairy industry developed the rst StrategicFramework or Dairy Farmings Future. That documentwas produced a ter wide consultation with thoseinterested in the continued development o dairy

arming in New Zealand. The purpose o the Frameworkwas to provide a set o high-level, aspirational goals

or the industry to achieve over the period 2004 to2014. These goals were to provide re erence points

or investment o industry unds in activities includingresearch, TB control, education, communicationsand extension.

DairyNZ, as custodians or the industry Strategy,initiated a project in July 2008 to update the StrategicFramework. This process has considered progressto date and signi cant changes which have occurredinternationally and within the New Zealand dairyindustry since 2004. This update covers a newtime rame: 2009 to 2020.

This Strategy is rst and oremost or New Zealanddairy armers, who have invested more than $60Balong with their time and energy into dairy arming.However, given the scale o the dairy arming industryin New Zealand, this Strategy must also be inclusive othe goals o other stakeholders. The most important othese stakeholders include:

Industry agri-business1. that armers rely on oradvice, products and services. Agri-business is animportant source o innovation;

The2. New Zealand economy bene ts substantiallyrom the dairy industry, and this Strategy must

consider the way that the dairy arming industrywill work with government to maintain thesebene ts; and

Dairy armers are committed to the stewardship o3.the natural resources that they rely on and a ect.The scale and scope o the industry means that weneed to work with central and local governmentand the public to ensure sustainable use othese resources.

Two key questions considered in this Strategyhave been:

What will increase the pro tability, sustainability and

competitiveness o New Zealand dairy armers?How will dairy armers arm in the uture?

How dairy armers arm in the uture will depend onhow they interpret the demands o the market and otherstakeholders, as well as what management optionsthey view as available and attractive. Providing options

or dairy armers that are aligned to the demands othe uture is ultimately the purpose o this strategy andrelated investment. As such, this document is structuredto address this question o uture demands, and toguide the investment and activities o the industry andother stakeholders.

The rst part o the Strategy outlines the context orNew Zealand dairy arming in the uture and whatchallenges have emerged. The second part identi esthe outcomes deemed necessary to meet thesechallenges. This Strategy di ers signi cantly rom the2004 Framework in two ways. First, a arming systemsapproach 1 is outlined as the best means o achievingthe outcomes or dairy arming, and this is then linkedto various components and strategies. Second,

implementation o this Strategy will depend on e ectivepartnerships between industry organisations andgovernment agencies.

2. Industry Context

How dairy armers will be arming in the uture will bedictated by both domestic and international drivers,and some o these have already changed in ways notanticipated in 2004. A broad outline o the context,

opportunities and challenges is summarised in thissection. The main changes to the context are alsodetailed in the External Scan attachment to this Strategy(Appendix).

Global supply and demand balance ordairy products avours New Zealanddairy armingThe dairy industry, along with other global oodcommodities, has a positive outlook with strong growthprojected in consumption. The 1960-2000 trend odeclining dairy commodity prices has been reversed inthe last decade, with dairy commodity prices and armerpayout trending upwards in real terms since 2000. Thehighest prices achieved in over 40 years were seenin the 2007/08 season, ollowed by a sharp decline.Caution is needed given the rule o thumb that prices orall commodities decline over time. The greatest growthin international demand or dairy products is rom Asia,due to population growth, a rapidly expanding middleclass and dietary changes to include western-style

oods. New Zealand has good trading relationships

in these markets, and they should bene t thedairy industry.

However, the Long Boom o global economic growthhas ended, and the world has entered a period o globalrecession. Price volatility in commodity markets (both

arm inputs and dairy products) and oreign exchangerates is resulting in higher uncertainty in arm returns.Marked increases in input costs or uel, ertiliser ando - arm eed occurred in 2007/08, though prices are

alling in 2008/09. The World Trade Organisation Doharound o trade negotiations has stalled, and NewZealands progress in securing ree trade agreementsmay not match that o key rivals.

The New Zealand dairy industry is predominantly anexport business, with less than 5% o productionconsumed domestically. New Zealand is the largestexporter o dairy ingredients in the world, accounting

or more than a third o the traded market. Thismeans returns to armers are highly dependent onthe international market with little domestic marketbu ering. In contrast to New Zealand, most o theworlds dairy production is consumed in the countrywhere it is produced. Only 5% o world productionis traded across borders. This means that relativelysmall variations in global production are ampli ed intosigni cant changes in the volume or trade. This in turndrives market volatility, and dairy armers are beingwarned to expect greater fuctuations in milk price thanpreviously experienced.

1 A arming systems approach integrates arm production and resourceuse, with arm business and people all in the context o the o - armdrivers on the dairy industry. This is illustrated in Section 4.

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Erosion o New Zealands low-costcompetitiveness poses a threatHistorically New Zealand dairy arming has held aposition as the lowest cost producer at the arm gate.Recently this position has been eroded as costs inNew Zealand have increased and other countries haveadopted lower cost systems, based on both pastoraland intensive models. While a alling New Zealand dollarmay alter rankings in 2009, the global trend to reducecosts o production is clear.

New Zealand land prices remain high and this, alongwith higher international milk prices, has encouraged thedeparture o New Zealand capital, skills and expertiseto establish low-cost pastoral arming systems in othercountries. This will accelerate the trend or increasedworld supply o milk rom low-cost producers.

Imperatives or productivity improvementremainThe 4% Total Factor Productivity target in the 2004strategy was ounded on the need or the industry tostay ahead o the 1960-2000 trend o declining dairycommodity prices. This trend has been reversed inthe last decade and in 2009, the real productivityimperative stems rom increasing arm input costs, and

the expansion o other low-cost dairy exporters whothreaten New Zealands position. The need to competeagainst low-cost producers in a volatile internationalmarket means that dairy armers must remain ocusedon resilient arming systems with relatively low

xed costs.

Productivity gains since 2000 have averaged 1% (Figure1). These have been made across the range o eedconsumed, cow productivity and labour e ciency.There is no evidence that single technology solutionswill be available be ore 2020 to step-change industryproductivity. This implies that productivity gains willcontinue to be broadly-based, with industry researchand development providing opportunities or individual

arms to make gains in di erent ways.

Figure 1. Productivity gains since 2001

Dairy industry makes a large and growingcontribution to the New Zealand economyNew Zealand has historically depended on the primarysector or its economic growth. Projections suggest thatthe pastoral and related ood industries will remain atthe core o the New Zealand economy through to 2020.Within the primary sector, dairy arming is the singlemost important economic activity in New Zealand. In theyear to June 2008, dairy products accounted or 25.1%($9.6 billion) o the nations total merchandise exports.Milksolids processed has grown by 4.4% per year since1998/99, against the Strategic Framework target o 3%growth. On the back o continued growth, the dairysector is orecast to grow export revenue to $11.9 billionin 2012, helping to li t the New Zealand economy out othe global recession.

Over time, the contribution o dairy arming to the NewZealand economy and agribusiness has been steadilyincreasing, e.g. increasing use o land or dairy arming

On- arm business successThe period since 1999 has been a success ul time orthe businesses o individual dairy armers. In this timethe pro tability o the average dairy arm has increased,on average, by $83/ha/year, with all o this attributableto productivity gains (pro t rom productivity or PFP;Figure 2). It is remarkable that the industry was ableto grow productivity at this rate as the same timeas increasing its size and the level o inputs intoindividual arms.

Figure 2. Operating proft since 1998/99

instead o sheep and bee , particularly in Canterburyand Southland. The importance o dairy arming tothe New Zealand economy has been recognised bycentral and local government. The signi cant impact o

dairy expansion and changes in payout prices are wellrecognised and reported in the regional media.

The contribution o the pastoral sector is highlighted inthe ollowing table.

Annual TFP Movement (%)

4.8%

3.1%

2.5%2.6%

-1.3%

average = 1% p.a.

-1.8%

-3.0%

2001 2002 2003 2004 2005 2006 2007

Table 1. Gross dairy exports and contribution to New Zealand land-based primary industry exports

Year to 31 March

Actual Forecast

2006 2007 2008 2009 2010 2011 2012

Dairy export revenue ($M) 6,807 8,404 10,478 12,044 10,471 10,887 11,897

Total NZ pastoral sector exports ($M) 11,143 11,406 13,420 16,881 15,783 16,704 17,955

Percent o pastoral sector exports (%) 56 60 63 70 71 66 65

Total NZ land-based primary industryexports ($M)

16,675 19,353 20,969 23,164 22,715 24,333 25,114

Percent o land-based primaryindustry exports (%)

41 43 50 52 46 45 47

Note: Pastoral sector includes deer, lamb & wool, bee , and dairy industriesLand-based primary industry includes kiwi ruit, wine, apple and pear, vegetable, arable, orestry, deer, lamb & wool, bee ,

and dairy industries

Source: Statistics New Zealand & MAF

Source: DairyNZ Economics Group

2,400

2,000

1,600

1,200

800

400

0

O P $ / h a

Actual OP $/ha OP $/ha with no productivity gains

1 9 9 8 - 9

9

1 9 9 9 - 0

0

2 0 0 0 - 0

1

2 0 0 1 - 0

2

2 0 0 2 - 0

3

2 0 0 3 - 0

4

2 0 0 4 - 0

5

2 0 0 5 - 0

6

PFP $/ha $834

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Land and stock values increased markedly, with theaverage dairy arm achieving a 7% annual gain in perhectare land values, be ore the price spike o the 2008year. The average dairy armer now employs assets

worth $5.3M generating a cash return averaging 3%over the last decade (DairyNZ Economic Surveys).

Public and consumers are driving newsustainability imperatives or dairy armingDairy armers have always had a strong sense ostewardship or their communities, arms and animals.

As the scope and scale o dairy arming has increased,armers and the industry are being challenged to

extend this stewardship ethic beyond the arm gate.Government and the public have increased expectationsaround environmental standards. This has led to agreater ocus by regional councils on water availabilityand quality which, combined with e fuent complianceissues and the expansion and intensi cation o dairy

arming, is increasing tension between the dairy armingindustry and the public. Despite the e orts o armersand industry to improve resource use e ciency, there isincreasing likelihood o urther constraints on water useand nutrient losses.

Agriculture is also in the spotlight as a key contributorto New Zealands greenhouse gas emissions. Dairy

arming is likely to bear signi cant costs (or requirenew mitigation technologies) in any emissions tradingscheme or carbon tax regime.

Globalisation remains a key orce, driving New Zealanddairy armers to acknowledge the changing demandsand pre erences o consumers around the world. Newimperatives include production systems issues suchas animal wel are and environmental ootprint, andalso product quality attributes such as traceability andproduct sa ety. These demands will change how armsare managed. Dairy armers need solutions to retaintheir competitiveness and access to global markets.

Skilled people are increasingly importanton arm and in the industryNew Zealand dairy arms are increasingly diverse andcomplex as they respond to new opportunities (e.g.automation, supplementary eeding) or pressures (e.g.labour shortages, winter management). Increasedcomplexity and diversity in dairy arm systems meansgreater skill is needed to arm, and also it challenges theidea o any single innovation working or all armers.

At the same time, arm ownership is changing to involvemanaging increasingly large-scale operations, with morethan 50% o sta now employed on wages comparedwith 29% in 1997 (DairyNZ data). Combined withindustry expansion, this leads to increasing demand

or arm managers and other workers. Larger and morecomplex arms mean that higher skills and greaterknowledge are required o this work orce. Signi cantchallenges or the industry exist around developingand retaining highly skilled sta . The competition orpeople is accentuating existing issues in the qualityo workplace conditions on dairy arms, and armerspeople management skills. These pressures highlightsome risks in maintaining supply chain security.

A unifed approach to innovation andadoption is neededThe unity and open in ormation sharing between dairy

armers have been important in the success o theNew Zealand dairy arming industry. Fragmentationo the processing industry has occurred ollowingderegulation, with direct competition betweenNew Zealand processors or both milk supply andinternational trade.

An increased number o arms are members osyndicated groups, with their own in-house processesand in ormation sharing. There has been a trend or armowners to not live on- arm (or in the region), removingleaders rom the community. Given the recognisedimportance o armer-led adoption activity, and the rolethat armer-to- armer learning plays in supporting

innovation it is important that the industry maintains auni ed approach and adapts to the changing nature othe people involved.

DairyNZ estimates that more than 1,000 ruralpro essionals are working with armers in commercialrelationships including vets, consultants, bankersand technical sales support people. These people arehighly infuential in armer decision-making, and theircompanies are o ten involved in supplying innovationthrough products and s ervices. Implementation othis strategy must engage agri-business in deliveringinnovation and high quality services to dairy arming.

Public perceptions about the dairyindustry are mixedOverall views o the dairy industry by the New Zealandpublic remain positive, with 65% o people surveyedreporting a avourable impression. 2 However, the overalltrend is in decline with greater appreciation o theeconomic bene ts o the industry being over-shadowedby increasing concerns about the dairy industryhaving a negative e ect on the environment. Withincreased pressure on local and central governmenton environmental management, and the need torecruit additional and more skilled people into thedairy industry - the mixed perception o the public is amajor concern and must be addressed. This will requireaction by armers and industry to improve complianceand demonstrate genuine stewardship or the naturalresources a ected. Only then will public perception startto change.

2 Public Perceptions o Dairy Farming and Advertising , UMR Research April 2008

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3. Industry Outcomes

The strategy is ocused on fve outcomes.The ongoing needs o individual armers or businesssecurity, combined with increasing input costs andgrowing international low-cost milk production, lead toOutcome 1: Increased Farm Proftability.

Growth and ownership changes in dairy arming meanthat more people are needed on- arm and in supportingindustries. The increased complexity, diversity andvolatility o dairy arming means that skill levels acrossthe industry need to improve. These actors combineto drive Outcome 2: Talented and skilled people areattracted to, and retained by the dairy industry.

Because o reliance on the international market,New Zealand dairy arming can only capture growinginternational demand or dairy products and deliverto armer and government economic aspirations byachieving Outcome 3: An internationally competitivemilk supply maximises returns to armers.

The industry currently has a mixed reputation orworkplace and environment practices, which posesrisks around regulation and attracting people. Howeverthere are market opportunities associated with NewZealands good reputation or product quality andsa ety. Together these drive Outcome 4: Industryreputation enhanced locally and globally.

Government, society and armers have shared, but notidentical, goals or the nations economy and the use onatural resources. Emerging pressures on the economyand resource use (water, greenhouse gases) highlightthe need to align these goals and lead to Outcome 5:

Achievement o shared goals through genuinepartnerships between industry and governmentand the wider community.

4. FarmingSystems Approach

For the industry to achieve the ve outcomes set outin Section 3, people and organisations must changethe way they think and act. Using a Farming Systems

Approach (illustrated in Figure 3) to design and

implement new options and policies will ensure thechallenges o increasing scale and complexity identi edin Section 2 are addressed.

The arming system comprises two main areas: the armproduction system (and consequent resource use) andthe arm management system (and the people involvedin its operation). These areas are tightly interdependent,because changes to any component require changes tothe whole. They are shown as being inter-linked at thecentre o the arming system diagram.

The broader context or dairy arming includes driversthat are outside the arm gate, and outside the directcontrol o armers. They are shown surrounding thecircle in the diagram. These are broadly grouped into

our areas: stewardship and social responsibility,governments and regulations, trade and consumers,and the New Zealand public. These areas are alsodynamic, as demonstrated by changes to the contextsince 2004 outlined in previous sections.

The Farming Systems Approach is needed because othe complexity o the issues and opportunities acing

armers. Faced with these challenges, it becomesclear that no part o the system can be considered inisolation. Production systems, people, and businessper ormance cannot be separated. And while the o -

arm drivers are outside individual armer control, theyare so important that armers must collaborate as anindustry and with other stakeholders to infuence their

uture direction.

For example, it is not use ul to:

breed aster-growing plants without considering the

implications or nutrient cycling and losses;

develop arm business structures or production

systems that dont consider the people who have tomanage them; or

design policy that limits armer fexibility in achieving

the policy goals.

While this concept seems obvious, experience suggeststhat it is not widely adopted at present. Although many

armers are already strongly committed to this widerarming systems approach, signi cant urther progressor the industry as whole is critical. Achieving this

progress requires the industry to overcome a lack oexperience and systems thinking by the people whoare part o the wider industry. This includes armers,researchers, rural pro essionals and policy developers.

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The Strategy will continue to place strong emphasison both the arm production and the people andbusiness areas but within the wider systems context oresponsible stewardship o land, water, and the widerenvironment. This includes public, regulator and marketperceptions o arming practices and armer attitudes.The Farming Systems Approach is a departure rom theoriginal Strategic Framework, where various strategicplat orms were treated as separate domains with theirown targets. In the past, solutions to issues have tendedto be developed in isolation and then tested to see ithey work within the system. In the uture, emphasis

will be on the system and solutions developed withinthat context. Adoption planning, there ore, should be anatural extension o any development.

Within the Farming Systems Approach there is a needor speci c direction, targets and strategies and theollowing sections o this document speci y these.

5. Industry Strategies

5.1 Farming Systems Designand Adaptation

Farming systems is concerned with the ability o theindustry to design new arm systems and adapt newoptions into existing arm systems. Farming systemdesign and adaptation is done in the context o theFarming Systems Approach, so explicitly includesconsideration o Farm Production and Farm Businessspheres and the wider industry context.

The ability o the New Zealand dairy arming industryto rapidly and e ectively adapt to new managementoptions and drivers in a arming systems context isseen as a major competitive advantage. When armerschoose new options that ocus, or example, only onimproving per cow per ormance or milk production inthe absence o the Farming Systems Approach, successis usually limited because poorly-considered criteriasuch as pro tability or e fuent management reducesystem per ormance.

This emphasises the importance o collaborationbetween industry stakeholders to ensure that newmanagement options and contextual drivers areresearched and worked through with armers in a

arming systems context. This involves both testing andvalidation on a scale that proves each concept, as well

as the collective e orts o the industry to implement thearming systems which best meet the overall objectives.

Figure 3. The Farming Systems Approach

Strategies

Generate new options rom research and1.development by universities, research teams,on- arm innovation and agri-business whichare integrated into arming systems withre erence to overall system per ormanceand regional variation.

Achieve armer adaptation, leading to higher2.per orming arm systems through:

E ective adoption approaches, involving all

parts o the industry networks.

Building capability in all parts o the industry.

Test government policy initiatives in a Farming3.Systems context, communicate these resultsback to government and infuence policy design.

FarmProduction& Resource

Use

FarmManagement

& People

Farming Systems

Consumers and trade

Stewardship and

social responsibilityThe central ocusis the whole arm

system

Farming systemsinteract and relate tothe broader context

Dairy armingoperates in the

context o a broaderworld

New Zealand Public Government andregulations

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5.2 Farm Production Systemand Resource Use

An e cient arm production system is an essentialcomponent or New Zealand dairy arming to beglobally competitive. The challenge is to understandand manage a biological system to increase on- armproductivity while reducing the environment ootprint.The challenge is urther extended because New Zealanddairy arming systems have become both more diverseand complex and hence one size ts all solutions areno longer realistic. Three urther dimensions o changeare critical or the arm production system: rstly, thesigni cant increases in input actor costs; secondly, theincrease in constraints in terms o access to water andto suitable land; and thirdly the requirement or qualityand valued milk.

The implication o these challenges or this Strategy isthe need or:

Scienti c breakthroughs at the level o both

component and systems research.

More e ective resource use through integrating

improved options into the arm sy stems.

Farming practices that ensure high quality and value

o milk production.

The goal o Farm Production is to add greater value toarm system per ormance through the application o

plant and animal-centred technologies and increasingproduct value.

The arm production system includes the domains oeed, animals, and milk value. The key strategies or

each domain are outlined below.

5.2.1 Feed and Animals

E cient management o a year-round system based ongrazed orage is seen as the key competitive advantageo the New Zealand dairy arming industry. Dairy armershave made signi cant gains in the amount o eedutilised on- arm in the last decade, with the majority o

these gains achieved through increased use o nitrogenertiliser and supplementary eeds. Gains rom pasture

improvement have continued to be slow, mainly as aresult o small annual increases rom plant breeding and

relatively low rates o pasture renewal.

Increasing the amount and quality o home-grownorage (both grazed and harvested) is a key part

o improving productivity and maintaining cost-competitiveness. This will be achieved through theuse o improved techniques to breed better plants, andthe integration o these plants into arm systems that

eature levels o pasture renewal that are optimisedto exploit the new plant material. These arm systemsmust utilise plant traits and management options toavoid increased orage production leading to negativeenvironmental impacts.

The dairy cow is the engine o the New Zealand dairyindustry, with 4.2 million lactating cows in New Zealandproducing more than 1.3 billion kilograms o milksolidsevery year. New Zealand is recognised as having aunique animal breeding and evaluation system thatcreates cows that are particularly suited to pasture-based production. Key dimensions o animal productionare to increase eed conversion e ciency o cowswhile improving longer term pro tability and long-termsustainability; and to optimise the pro table li etime milkproduction o a cow.

Ongoing support is required or development o newplant and animal genetics or production e ciency and

unctionality, maintenance and enhancement o theanimal evaluation system and supporting developmento industry capability.

New initiatives include an emphasis on increasedresource use e ciency (water and nutrients) utilisingplant and animal genetics and management. Also neware the proposed development o an integrated plantevaluation system and investment into the increaseduse o automated and in ormation technology-basedapproaches to arm production.

5.2.2 Milk Value

The New Zealand dairy system is recognisedinternationally as a supplier o milk that is worlds best interms o ood sa ety, processability and intrinsic value.

The importance o ood sa ety elements has beenheightened in recent years as a result o examples suchas contamination o a commercial organic spinachproduction system in the United States, melaminecontamination o milk in China, and concerns aboutresidues in honey and wine exported to Europe and theUnited Kingdom. Achieving integrity o the milk supplychain in terms o ood sa ety and quality at the highestlevel has been, and should remain, a critical intrinsicvalue-enhancing actor or New Zealand milk.

The New Zealand dairy system is characterised bya large-scale milk collection and processing system,with only smaller volumes being targeted or speci csupply to meet the requirements o more di erentiatedmarket opportunities. The arming system has to ensurethat the inherent milk attributes are suitable or large-scale processing or are aligned with specialist-scaleopportunities.

Strategies

Invest in:1.

Increasing adoption o existing bene cial

technologies.

Developing new technologies to increase

potential milksolids production rom orage,potential eed conversion e ciency, cow

unctionality and resource use e ciency.

Developing measurement and management

tools or on- arm decision making.

Maintain and enhance the animal evaluation2.system including the genomic and nationaldatabases, the capture o herd testing andother phenotypic data and the introduction oimproved and new traits.

Increased cow unctionality through3.improvements in:

Animal health including reproduction,

lameness, mastitis and acial eczema,BVD, EBL.

Traits and management that support arm

systems productivity (e.g. milking s peed,calving ease).

Develop an industry-endorsed, quantitative plant4.evaluation system that integrates a orage valuemethod (akin to production worth) with physicalper ormance testing at a range o scales.

Ensure the long-term potential o arm5.production to:

Deliver a regulatory regime that supports

the agreed use o new plant and animalmaterial based on both conventional andbiotechnology based breeding.

Maintain and develop relevant capability

throughout the industry.

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Note that beyond the arm gate, the development onew products, specialty milks and increasing valueo existing products will be undertaken by each dairycompany where proprietary rights can be protected.Much o this will be done under the Consumers andTrade part o Industry Sustainability (Figure 3). Eventhe development o improved milk attributes whichare deemed as industry good will be undertakenin cooperation with milk processors recognising theimportance o managing the whole value chain with theconsumer as the ultimate customer.

5.3 Farm Management SystemsE ective arm management is essential to thecompetitiveness o New Zealand dairy arming systems.The industry is changing rom predominantly smallto medium-sized dairy arms under amily ownershipto an increasing number o large arms with complexmanagement structures. These changes are requiringnew capabilities o people in the industry, such asthe skills to manage multiple arm operations. Largeroperations encounter new challenges like managinga number o sta , with each person having di erenttraining or motivation needs. Dairy armers also acethe challenge o new requirements rom the public andlocal government with respect to water access or waterquality that impact on choice o arming practices.

Finally, the industry is challenged by the number oowner-operators who are in late career, resulting insigni cant succession planning requirements.

These challenges have implications or the peopleand businesses that underpin the industry growthanticipated in this strategy, namely arm managerswill need:

Advanced business management skills, including

the ability to plan and adapt under conditions o risk.These skills span production, nancial andlegal issues.

An improved working environment that attracts and

retains talented people.

To grow people through career development and the

provision o worlds best training opportunities.

The goal o Farm Management Systems is to provideNew Zealand dairy arm businesses with the humancapacity to achieve both short and long term goals.The Dairy Business (Section 5.3.1) and Dairy People(Section 5.3.2) strategies rein orce each other to achievethis overarching goal.

5.3.1 Dairy Business

The e ective implementation o appropriate businessmodels and practices are key oundations or individualbusinesses to be competitive internationally. To achievethis outcome, dairy business managers will need the

nancial and business skills to evaluate di erent optionsto achieve their desired goals. The industry will alsoneed to provide in ormation that supports improveddecisions, together with the tools and processes thatenhance arm management skills development.

Together these strategies need to support dairy armerse orts to retain access to quality land, water andhuman resources that underpin the sustainability othe industry.

5.3.2 Dairy People

The longer-term success o the dairy industry willdepend on attracting and retaining talented peopleand growing these individuals using e ective skillsdevelopment programmes. Success will occur whentalented, skilled people are attracted and retainedbecause they are rewarded as the industrys keyinvestment or the uture.

There is a need to achieve a much greater publicrecognition o the exciting career prospects whichexist in the industry. The challenge is to achievethis vision when the industrys public image hasbeen challenged with respect to environmental andemployment practices.

Strategies

Achieve highest quality on- arm storage1.and management o milk with respect tobacteriology, inhibitory substances andtraceability.

Achieve positive changes to milk composition2.and value rom on- arm modi cation (e.g.genetics, nutrition). Ensure that any e ects onew arm management systems and productson the supply chain (through changes in milkprocessing, composition or ood edibility) areunderstood and considered.

Strategies

Ensure managers have the business skills to1.identi y their goals and implement their plans.Build management capabilities through:

Appropriate education

Research

On- arm training and extension.

This strategy relates directly to strategy3 in section 5.3.2 Dairy People (CareerDevelopment).

Ensure a high-quality in ormation resource is2.developed to serve two unctions:

Managers can access in ormation on key

external actors a ecting their strategicdecision making.

Industry level analysis provides e ective

advocacy, support and representation orthe New Zealand dairy industry, includingpro ling the economic value o the industryto the New Zealand public and government.

Ensure that dairy businesses have access to3.improved tools and methods to analyse andimplement management options to:

Make investment decisions and manage risk

(e.g. business resilience indicator).

Ensure rural pro essional networks are

up to date with business trends andanalytical methods.

Develop e ective approaches to

succession planning.

Strategies

Attract talented people:1.

The industry promotes dairy careers to

school-leavers, tertiary students and earlycareer change individuals.

Ensure people in the industry are

ully in ormed o career and businessopportunities in dairy arming, and know howto access these opportunities.

Infuence government on legislation relating

to immigrant workers.

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5.4 Industry SustainabilityMany issues and opportunities a ecting dairy armersrequire collective action with a number o playersworking together to achieve desired outcomes. WithinNew Zealand, large-scale issues such as greenhousegas emissions, catchment management and water/ energy supply a ect the sustainability o the industrybut require many organisations to align their actionsto achieve success. Internationally there has beenincreasing pressure rom consumers and retailers, toensure good arming and supply chain practices. Thisincludes the environmental impact o arming practices,the energy ootprint ( ood miles), ood sa ety andproduct integrity, and animal wel are and biosecurityissues (e.g. tuberculosis).

Achieving industry sustainability relies on success ulinteraction with central and local governments aroundregulation and trade issues, ongoing con dence ointernational customers in the quality o New Zealandmilk, and support rom the New Zealand public.

This part o the Strategy ocuses on the actions thedairy industry needs to take to infuence outwards

rom the dairy arming system to the world. The FarmSystems, Farm Production and Farm Business parts othe Strategy contain the dairy arming level responses

that need to be made to deliver on and implement theagreements reached between the industry and theexternal drivers.

The strategies to enhance industry sustainability havebeen organised under the our themes surrounding theFarming Systems circle in Figure 3.

5.4.1 Stewardship and Social Responsibility

Promote and support research, arming practices1.and activities that instil pride in dairy arming,progress people and society, and rein orceresponsible land use.

Identi y, develop and protect essential capabilities,2.assets and resources required or the uture good othe New Zealand dairy industry.

5.4.2 New Zealand Public

Ensure the dairy industry is highly regarded or3.its contribution to national wealth, employmentopportunities and career satis action.

Promote armer achievements in producing quality4.products, resource stewardship, environmentalsustainability and animal wel are.

5.4.3 Consumers and Trade

Work closely with central government to ensure1.access o dairy products to all markets:

Ensure in ormation is produced and practices

are in place so that the dairy industry candemonstrate that New Zealand dairy cows havede ensible physical, health and behaviouraloutcomes within commercially viable

arm systems.

Ensure marketing o products is enhanced (or

at least not constrained) by the environmentalachievements o New Zealand dairy arming.

Pro tably grow the supply base and logistics2.or current specialty milks ( or example organic

milk, stole, colostrum, kosher milk) to satis ymarket demand.

Achieve gains in milk value throughout the3.processing and marketing chain through productand processing innovation, quality and sa ety,logistical e ciencies, marketing partnershipsand improved market access (including inter-governmental initiatives).

Ensure the New Zealand dairy industry is, by all4.practicable means, protected against potential andrealised incursions o exotic pests and diseaseswhich may signi cantly harm dairy armingdomestically or restrict export to all markets.(Noting the overall responsibility or New Zealandsbiosecurity is with the Ministry o Agricultureand Forestry).

5.4.4 Governments and Regulations

Ensure all plans and policies developed by local1.and central government relating to land use,resource availability, energy and environmentalconcerns are based on sound scienti c, economicand social principles.

Establish benchmarks and targets or increasing2.resource use e ciency and guiding good practice.

Deliver tools, technologies and management3.practices capable o signi cantly reducing o - armlosses o nitrogen, phosphorus and greenhousegases and signi cantly increasing wateruse e ciency.

Work with dairy armers to meet all requirements4.and negotiated agreements with local and nationalgovernment by providing viable practical options.

Develop a quality work environment:2.

Dairy arm businesses are employers o

choice who use best practice approaches torecruit and develop sta .

Develop agreed indicators and targets or

arm in rastructure, labour productivityand utilisation.

Research labour productivity to create new

options or arming practices, e.g. armingautomation and precision dairy systems.

Promote on- arm innovations that improve

the work environment.

Develop dairy peoples careers:3.

Ensure the entire work orce has the

requisite skills and knowledge to innovateand adapt to capture opportunities andmanage the challenges con ronting dairy

arm businesses.

High-quality training services are developed

by working with government and educationorganisations to ensure they are aligned withindustry priorities.

Ensuring leadership programmes are

creating a talented pool o people toinfuence policy and industry strategy.

Develop mentoring and coaching

programmes that ensure employers,employees and rural pro essionals areli elong learners.

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6. Measures of Success

The industry needs measures against which to judge progress in achieving the ve outcomes. Descriptors o successand proposed measures are outlined below in Table 2.

Table 2. Outcomes and Measures o Success

What will success look like (industry target)? How will we measure it (industry measures)?Outcome 1Pro t rom Productivity increases by $110/ha/yr.

Annual reporting o aggregate data or PFP

rom DairyBase.

Outcome 2 All dairy industry businesses report their demands ortalented and skilled people are being met by the labourmarket and through pro essional services.

Annual reporting o industry employment surveys o

Access to skilled employees

Retention o sta

Use o best practices or managing people

Access to skilled pro essional advice.

Outcome 3 Milk is produced at a competitive cost, quantity andquality in relation to other countries and protein sources.

Annual reporting o competitiveness indicatorspotentially including:

Cost o milk production

Pro t margins achieved or dairy products in overseas

markets compared with other producers and proteinsources/milk substitutes.

Outcome 4 Industry reputation enhanced in New Zealandand overseas:

Public regard the industry as a good place to

work and as producing a quality product throughstewardship o land and water resources.

Dairying is valued as an economically important

industry to New Zealand

Access to international markets is enhanced.

Annual reporting o :

Industry rating on the Lincoln University and industry

UMR public perception surveys

An indicator o changes in market access.

Outcome 5 The dairy industry and government success ully negotiateand implement solutions that:

Grow arm pro tability

Enhance the reputation o the industry

Build a competitive milk supply

Attract talented people

Address priority issues, or example GHG, water

quality, energy and water use.

Annual reporting against an industry work planthat identi es:

The issues the parties need to address,

and progress in negotiating solutions

Progress by all parties to meet their

negotiated obligations.

Strategy for New ZealandDairy Farming 2009/2020

Appendix: External Scan Update

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Appendix: External Scan Update

SummaryThis document updates the environmental scan inthe original 2004 Strategic Framework, and ocuses onthe signi cant changes that are apparent in early 2009.The changes highlighted or New Zealand dairy armingare in the context o globalisation, and the recentdevelopment o global recession. There are our mainthemes emerging.

Loss o New Zealandslow-cost competitivenessNew Zealand dairy arming has lost its competitiveedge according to the International Farm ComparisonNetwork. While this position may change with a allingNew Zealand dollar, New Zealand land prices remainhigh and have accelerated the departure o NewZealand skills and expertise to establish low-costpastoral arming systems in other nations.

Imperatives or productivity improvementThere are many actors including increasing arm inputcosts and threats to sustained export returns that meanon- arm productivity improvement remains a priority.However, global dairy commodity prices achievedtheir highest prices in over 40 years in real terms in2007, which indicates that productivity improvementso 4% per annum have not been necessary to sustainthe pro tability o dairy arming in the last ve years.However declining real prices or dairy commodityproducts remains a risk. Increasing costs and greaterprice and currency volatility suggests that dairy armersmust still remain ocused on resilient arming systemswith relatively low xed costs.

Emergence o new imperativesor dairy arming

There is a clear tension between ambitious productionand productivity goals and the reduction o dairy

armings environmental ootprint. Agriculture is alsoin the spotlight as a key culprit or global warming,and may need to bear signi cant costs. Otherimperatives are also emerging around satis yingthe demands o global retail companies and theircustomers expectations. These demands all changethe requirements or how arming is managed, andwhat solutions are needed to remain competitive andacceptable in the global market.

Complexity and diversity on the armNew Zealand dairy arms are increasingly diverse andcomplex as they respond to these new imperativeswhile also seeking to increase productivity. At the sametime, arm ownership is changing to be increasinglylarge-scale with a higher proportion o sta thanunder the traditional owner-operator model. Thereare signi cant challenges or the industry arounddeveloping and retaining highly-skilled sta . Thesepressures highlight some risks in maintaining supplychain security.

1. Introduction

The update o the strategic scan rom the 2004Framework must acknowledge the power ul mega-trends and global events that are vitally importantto the New Zealand dairy industry, and that set the

overall context in which it operates. These includeglobalisation, and the economic state o the world.

Globalisation remains a key orce, drivingNew Zealand dairy armers to acknowledge thechanging demands and pre erences o peoplearound the world

New Zealand Treasury de nes globalisation as thetrend towards increasing global economic integration,and notes that the current period is unprecedented 1.The pace and extent o globalisation will have majorrami cations or the world, regional and New Zealandeconomies. It is also highly unlikely that theseprocesses will be reversed.

Globalisation involves a combination o economic,technological, sociocultural and political orces. These

orces shape the integration o national economies intothe international economy through trade, oreign directinvestment, capital fows, migration, and the spread otechnology. What this means or the New Zealand dairy

armer is that it is not su cient to simply operate withinthe con nes o a small rural community. The saleability

and value o a dairy armers production is increasinglytied to the demands and pre erences o people indistant countries. These demands relate not only to theproduce itsel , but how it is produced and with whatimpact on the environment.

The Long Boom has ended, and the world hasentered a period o global recession

The Long Boom re ers to an extraordinary periodthrough the 1980s and 1990s o nearly continuouseconomic growth and declining or low infation indeveloped countries, particularly the United States.Some commentators pointed to the end o this boomperiod in 2001, and alarmists worried then that theUnited States was on the verge o recession. These

ears were evident in 2004, but could be discounted as

there was no actual evidence o a recession. However,in 2008 the world entered a state o economic crisisprecipitated by the collapse o the United States sub-prime market, and world commodity prices have allensubstantially.

A key issue or New Zealand dairy armers is howrenewed intervention by the European Commission andUnited States Government may urther impact low dairyprices. Prompted by alling dairy commodity prices inmid-January 2009, the European Union announced theresumption o dairy export subsidies, while in the UnitedStates the Government Commodity Credit Corporationhas begun to stockpile skim milk powder. The UnitedStates Government will come under increasingdomestic political pressure to subsidise the export

o this stockpile onto world markets, urtherthreatening prices.

On the local ront, the New Zealand dollar has allen toa ve-year low against the United States dollar in March2009. What is important to New Zealand dairy armersis how these volatile conditions a ect their payout, howthe negative economic sentiments a ect prospects orworld trade, trade nancing and capital fows, and howlong this recession might last.

1 The Risks and Opportunities rom Globalisation, New Zealand TreasuryWorking Paper 07/05, July 2007

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The dairy industry along with other global oodcommodities still has a positive long-term outlook

In spite o the current recession, world dairy marketsare evolving with strong long-term demand growth ordairy imports in several key regions. Asia stands out asthe region with the highest dairy consumption growthand relatively low supply growth, and this imbalanceis driving the growth o imports. This is particularlytrue o China. Underlying this consumption trendis the expansion o the middle classes in Asia, andthe westernisation o Asian diets to include greaterquantities o dairy products. This trend is not expectedto reverse in the current economic crisis. New Zealandis well positioned to supply Asia because o its globalproximity and also positive economic and trade relationsin the region.

A rica, Central America and the Middle East are similarlyregions with increasing demand or imported dairyproducts. The supply de cit is not as marked as or

Asia, and these regions are also placed more closely to

other dairy exporters that compete with New Zealand.

The European nations are likely to work out a newtrade balance with Russia and the ormer SovietUnion nations expanding production. Some concernarises rom the likelihood o these exporting nationsincreasingly competing directly with New Zealandexports into A rica and the Middle East. Similarly, South

America is well placed to export to Central and North America as well as the Paci c Rim countries.

2. InternationalCompetitiveness

The New Zealand dairy industry is o ten hailed as aglobal leader, being the worlds largest exporter o dairyingredients. This leadership is ounded on the ability tocompete internationally with high-quality, lower-cost

dairy production. In part, the success o the industryis due to a remarkable level o cooperation. Thiscooperation is evident at all levels, rom the cooperativeownership o dairy companies, the creation o industryassets such as the animal evaluation unit, and the wayin which New Zealand dairy armers assist each otheron a daily basis to achieve greater levels o productivity.The New Zealand pastoral arming system is alsoremarkably resilient, because o the ability to adapt tochanging economic circumstances by maintaining arelatively low xed cost structure.

New Zealand has slipped in the rankings olow-cost milk production since 2004In 2003, New Zealand claimed to be amongst thelowest cost dairy producing nations in the world. TheInternational Farm Comparison Network reported only

Argentina to have lower costs. North America and mosto Europe were considerably less competitive. However,since that time New Zealands cost o milk productionhas increased while South and North American nationsas well as regions o Europe, Asia and A rica have

become more competitive. As a result, there is nowevidence that New Zealand dairy armers no longer havea competitive cost advantage.

In part, this reportedly higher cost o production isdue to a high New Zealand dollar. The recent all inthe value o the New Zealand dollar against theUnited States dollar will go some way to restorethis cost competitiveness.

However, another actor is the appreciation o NewZealand land values. In February 2008, dairy armprices hit records highs. The dairy arm median price

or the three months to January 2008 was recorded asNZ$4.3 million 2. This compares to a dairy arm medianprice o approximately NZ$2.0 million in 2004. Theseincreases mean the average price per hectare increasedto over NZ$37,000, with the land price per kilogram omilksolids rising to well over NZ$40.

Source: DairyNZ Economics Group CAGR = compound annual growth rate

P r o

d u c

t i o n

G r o w

t h ( C A G R )

Growth %

Consumption Growth (CAGR)

6%

5%

4%

3%

2%

1%

0%

0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%

Former Soviet UnionRussia

South America

India/Pakistan

A rica

Central America

North America Asia

Other EuropeEU-25

Middle East

Potentially greater exportsas supply expands asterthan domestic demand

Moderate market opportunitywith demand growing asterthan local milk supply

Large market opportunity withdemand rapidly outstrippingsupply capacity in highpopulation areas

Figure 1. Global Dairy Market Opportunity

2 Real Estate Institute o New Zealand

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The increasing movement o New Zealandcapital and expertise to establish lowercost pastoral dairy systems in oreigncountries with lower land pricesThe last decade has seen an increasing movemento New Zealand capital and expertise to establish thesame dairy arming systems in regions with cheaperland but comparable soils and climate. Several highpro le initiatives have sought not just armer capital,but also unds rom retail investors to establish NewZealand dairy arm systems in South America. Forexample, since launching in 2006, NZ Farming SystemsUruguay (managed by PGG Wrightson) has acquired36,300 hectares or dairy conversion in Uruguay. Thisalone represents approximately 3% o New Zealandsdairy arming land. Similar projects are ocused onvarious other South American nations, Eastern Europeand regions o the United States. These enterprisesdraw on not just capital, but also the expertise o NewZealand dairy armers.

This international movement o New Zealand capitaland expertise o shore has several implications. In the

rst instance, it suggests an inevitable erosion o NewZealands competitive advantage over these countries

which have been traditionally dominated by NorthernHemisphere intensive dairy systems and genetics. Itis also likely to accelerate the growth o these nationsdairy production volumes, ultimately competing directlywith New Zealand dairy production on internationalmarkets. On a more positive note, New Zealand maybene t rom the repatriation o innovations developed oruncovered by these initiatives and greater coordinationbetween producing countries.

New Zealand dairy armers must anticipate thatthey will not remain the sole exporting nation witha competitive cost advantage based on extensivepastoral arming systems.

3. Imperatives for ProductivityImprovement

The 2004 Strategic Framework or Dairy FarmingsFuture set productivity improvement as the highestpriority. The apparent loss o competitiveness outlinedin the previous section underlines the importance o

this approach. However, the original justi cation orproductivity based on declining world commodity pricesis not necessarily so clear.

Global non- uel commodity markets experienced along-run decline in real values or our decades upuntil approximately 2000. With the exception o a smallspike coinciding with the oil-shocks o the late 1970s,an annual decline o nearly 2% was experiencedacross this whole period. In comparison, petroleumcommodities have shown considerable volatility. Thesehistorical indices are shown in the chart below 3.

Figure 2. Commodity Price Index

This trend was also evident in the dairy industry andparticularly through the 1990s when it was one othe key actors leading to a ocus on productivityimprovement to remain cost-competitive. Thisculminated in 2000 with a report by the McKinseyGroup recommending that the dairy industry set a 4%p.a. productivity target to o set the underlying trend ocommodity revenue declining by 2% p.a. 4

A signifcant reversal o the 40-year trendin declining global dairy commodity pricesin real terms, with the highest pricesachieved in over 40 yearsThe 1960-2000 trend o declining dairy commodityprices has been reversed in the last decade, withdairy commodity prices actually trending upwards inreal terms since 2000. This is shown in Fig. 3 whichrepresents milk revenue based on internationalcommodity prices 5. Thus the imperative or productivityimprovement based on a historical expectationo declining commodity prices appears to be lessrelevant. The real productivity imperative stems romthe expansion o other low-cost dairy exporters whothreaten New Zealands position, and where there

is the uture potential or intense internationalprice competition.

CAGR = compound annual growth rate

250

200

150

100

50

0

Indexed price

Nonfuel commodities CAGR = -1.9%Petroleum commodity CAGR = 3.2%

1 96 0 1 96 5 1 97 0 1 97 5 1 98 0 1 98 5 1 99 0 1 99 5 1 99 8 1 99 9 2 00 0

3 World Bank Group Data

4 McKinsey & Co. Driving On- arm Productivity, June 1999

5 Real 2008 prices adjusted or world infation, based on stream revenueto a hypothetical New Zealand product mix.

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Price volatility in commodity marketsas well as oreign exchange rates isincreasing, resulting in higher uncertaintyin arm returns

A key eature o the dairy commodity prices between2004 and 2008 is the greater price volatility evident inthe last decade, and also high volatility in NZD:USDcurrency rates which have swung between extremes o0.80 and 0.40. These two actors are crucial drivers ouncertainty in export revenues to the dairy sector. Thecooperative model prevalent in the New Zealand dairyprocessing and marketing sector means that this risk ispassed largely to dairy armers in the payout, which istheir primary source o income. This has implications orthe appropriate risk pro le or dairy armers to adopt.Farmers average debt to equity ratios have remainedquite stable at between 31% and 37% over the past10 years.

Figure 3. Dairy Commodity Revenue

Fragmentation o the processing industrypost-DIRA, with direct competitionbetween New Zealand processors in bothmilk supply and international trade

At the introduction o the Dairy Industry Restructure Act (DIRA) in 2001, Fonterra was responsible or96% o the industrys milk collection. Two smallerincumbents, Westland and Tatua, accounted or theremaining amount. This picture had not changedgreatly by 2004, but since then new independent dairycompanies have become established. Much o thisnew independent investment has been enabled by theDIRA ramework which requires Fonterra to supply rawmilk to competitors. Even with the postponement othe Mataura Valley Milk plant proposed or Southland,Fonterras share o milk processing may be reduced toapproximately 92% in the 2008/09 season.

Figure 4. Share o New Zealand Milk Supply

There is now greater competition in New Zealand tosecure raw milk supply, and armers are scrutinisingthe dairy companies or who can provide the greatestreturns. This is placing considerable pressure onthe dairy companies to be e cient. At the other endo the business, the processors are all selling intointernational markets, which brings greater potential

or price competition between New Zealand-sourced

milk products. This suggests that in the s hort-term,dairy armers can expect e ciency gains and highermilk prices rom dairy companies, especially whereprocessors are competing. In the longer term, however,

competition between processors may erode exportreturns unless there is some degree o cooperation ormutual advantage.

Threats to the cooperative model o theNew Zealand dairy industryThe dairy industry is also struggling to reconcile thecooperative ownership model with the aspirations oa large multinational dairy company. Most recently,Fonterra announced a pre erred option in November2007 to create a new company to own all the assets othe existing cooperative. This new company would havebeen listed on the stock exchange with the cooperativeretaining a majority holding. In the event however,Fonterra postponed this initiative in recognition o theneed to consult urther with armers. Nonetheless,when considered in conjunction with the rise o newdairy companies which are largely investor-owned,there is a very real possibility the dominance o thecooperative model will be seriously challenged over thenext decade. This has implications or the leadership othe industry, particularly by armers, and how they will

respond in a coordinated way to new challenges inthe uture.

Marked increases in input costs or uel,ertiliser and imported eed

Dairy armers have experienced an increase in inputcosts coinciding with the increase in commodity pricesgenerally 6. The most signi cant increases have beenaround uel prices and electricity, which have eachincreased by 130% and 90% respectively since 2000.Prices related to eed and ertiliser have increased bynearly 50%. Together with labour, this has resulted inan increase in the overall input price index o 35%,signi cantly more than underlying infation. The cost oenergy in particular refects New Zealands exposure toworld markets or inputs to arming.

Figure 5. Index o Major Dairy Farm I nput Prices

The increases in input costs are also refected in thearm accounts. In the 2000-01 season, arm working

expenses were $2.58 per kgMS. By the 2007-08season, these costs had increased to $3.39 per kgMS.Fortunately, the very high payout o 2007 more thano set these increases but the so tening in world dairymarkets this season (2008-09) sees increasing pressureon dairy arm operating pro ts. With it comes a return tothe ocus on increasing arm productivity as an absoluteimperative, despite recent drops in input prices.

$1,200

$1,100

$1,000

$900

$800

$700

$600

$500

$400

USD/kgMS(2008 $)

Year

J a n - 0

0

J u n - 0

0

N o v - 0 0

A p r - 0 1

S e p - 0

1

F e b - 0

2

J u l - 0 2

D e c - 0

2

M a y - 0 3

O c t - 0 3

M a r - 0 4

A u g - 0

4

J a n - 0

5

J u n - 0

5

N o v - 0 5

A p r - 0 6

S e p - 0

6

F e b - 0

7

J u l - 0 7

D e c - 0

7

M a y - 0 8

New Zealand Dairies1.1%0.5%

0.9%

3.1%

95%

1.3%

0.8%

1.1%

0.9%

3.0%

92%

Synlait

Tatua

Open Country Dairyincl. OCC

Westland

Fonterra

Incumbents

2006/07 2008/09

140%

120%

100%

80%

60%

40%

20%

0%

Price Indexvs. 2000

ElectricityFeed, Grazing, Cultivationand HarvestingFertiliser, Lime and Seeds

FuelWages and SalariesOverall Farm Expenses

2001 2002 2003 2004 2005 2006 2007 2008

6 Sourced rom DairyNZ economics group

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Competition or resources betweenalternate land uses has been to theadvantage o dairy arming, but this hasalso exposed the industry to a greater

risk o contraction under less avourableeconomic conditionsDairy arming in New Zealand has provided strongreturns to owners, mostly through appreciation o theland itsel . In the years rom 1998 to 2007, operatingreturns have been approximately 4.4% per annum whilecapital returns have been slightly higher at 4.9% perannum. Total returns have hence been just under 10%per annum 7. A ter the 2002/03 land price correction,land appreciation resumed to peak at 15% in 2005. Thisgenerally refects the tendency or armers to capitaliseoperating returns in the value o the land itsel .

Figure 6. New Zealand Dairy Farming Proft andReturn on Assets

The key to wealth creation through arming is the abilityto make operating pro ts above alternative land uses.In this sense, dairy arming has been more success ulthan sheep and bee arming whose operating returnshave generally been less than 2% per annum. Thiscomparative nancial success has a orded dairy

armers the means to expand through the conversion

o other land uses to dairy. This has meant ull armconversions, particularly on more marginal land, aswell as incorporating the resources o other land intothe dairy plat orm with run-o s and purchased eed.

It has also unded more intensive use o inputs suchas ertiliser.

However, given the current adverse economicconditions, some o which are created by internationalcompetition or resources (i.e. increases in Chineseconsumption o ertiliser), New Zealand dairy armersmay nd it more di cult to justi y this expansion. Theslowing o growth, or even contraction o the industryunder certain conditions, is a very real possibility.The marginal land conversions and systems using asigni cant amount o imported eed are most vulnerable.

Limited progress since 2004 on signifcantbiotechnology advances on- arm to createa step-change in productivity across thewhole industryThe ambitious productivity targets outlined in theoriginal Strategic Framework were not without some

justi cation. For example, early evidence suggestedthat two key innovations around nitrogen inhibitorsand also pasture endophytes (AR37) would makemajor contributions to mitigating nitrogen leaching andincreasing pasture productivity. However, both theseinnovations have proved to be use ul options in certainconditions, but not universal solutions. The e cacyo nitrogen inhibitors appear dependent on soil andclimatic conditions and soil conditions, and the AR37ryegrass endophyte is also e ective but not in all cases.Both these ndings came to light in 2008, and when weconsider the time it takes or an innovation to be widelyadopted, they highlight that the dairy industry must notanticipate step-change innovations in dairy armingproductivity as the solution to all its challenges.

The inevitable conclusion is that New Zealand dairyarmers must meet the productivity challenges

both using existing technologies, and by e ectivelyintegrating new options into their arm systems. The

skill and resource ulness o dairy armers in managingthe undamentals o the arm system remains the mostimportant actor.

The Doha round o trade negotiations hasstalled, and New Zealands progress insecuring ree trade agreements is only nowstarting to match that o key competitorsThe Doha Development Round is the current trade-negotiation round o the World Trade Organisation(WTO) which commenced in November 2001. Itsobjective is to lower trade barriers around the world,which allows countries to increase trade globally. Therewas a reasonable expectation as recently as 2004 thatthese talks would make progress and deliver a trade-enhancing deal.

However, the talks have stalled over a divide onmajor issues, including agriculture. In particular, thereis considerable contention between the EuropeanUnion, the United States and developing countriesover agricultural subsidies which operate e ectivelyas trade barriers, and high agricultural tari s whichremain in many parts o the world. The most recentround o negotiations in July 2008, broke down entirelya ter ailing to reach a compromise on agriculturalimport rules. Some parties claimed the agriculturetalks were harmed by the ve-year programme oagricultural subsidies recently passed by the UnitedStates Congress. In any case, major negotiations willnot resume until mid-2009 at the earliest, and awaita clear indication o intent by the new United States

Administration.

In lieu o progress in the WTO, New Zealand has beennegotiating a series o bilateral trade agreements.This alternative route to trade liberalisation is beingpursued by many nations. New Zealand signed a reetrade agreement (FTA) with China in 2008 and in early2009 completed a deal with the ASEAN nations. Otherrecent developments include the potential or FTAswith Korea, India and Hong Kong and the Trans-Pacagreement which would bring together New Zealandand the United States along with a number o other

Asia Paci c economies. These agreements tend to beavourable to New Zealand dairy exports, and in key

dairy markets. However, overall progress to date haslagged behind that o our partners and competitors.

Australia already has a FTA with the United States whichis a key market, and has a number o other initiativesunderway, including with Japan. Chile has securedagreements across North, Central and South Americaas well as with many Asian nations. As a small nation,New Zealand is a somewhat lower priority or the largernations and also more vulnerable to accepting less

avorable terms. Another key concern is that bilateralFTAs do not address the reduction o other countriesagriculture subsidies which is important or the NewZealand agriculture sector. What this means is thatwithout progress o the Doha round, the New Zealanddairy industry will continue to compete with subsidisedproduction rom other countries. On the FTA ront,while signi cant deals are in the o ng, it will still besome time be ore New Zealand has caught up withkey competitors.

Average New Zealand Dairy Farm

30

25

20

15

10

5

0

-5

-10

% Return onOpening Assets

1998-99

1999-00

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

Operating Retur n Capital Return Total Retur n

7 DairyNZ Economic Farm Survey. 2006/07

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The risk o the deep global recessioncontributing to a reversal o gainsmade through trade liberalisation, andconsequent impacts on New Zealands

market accessThe current global recession presents some risks tothe World Trade Organisation. The WTO is alreadyweakened by the stalled Doha round, but nonethelessserves an important role as a legal stop to protectionismand as an arbitrator o the rules-based trading system.However, as the global recession deepens, and underthe most pessimistic scenario, some nations may tryto create more protectionist policies that violate theirWTO commitments and orce the WTO to intervene.In the event that nationalistic tendencies then lead theo ending party to reject the ruling o the WTO, it couldbe atal to the system and lead to an unwinding ocurrent trade rules. New Zealands trade is particularlyvulnerable to such an event, and it would inevitablyresult in lower export returns to dairy armers.

In summary, competitive threats rom low-cost exportersas well as increasing arm input and compliancecosts provide su cient cause or New Zealand dairy

armers to place great importance on achieving greaterproductivity. The likelihood o high volatility in exportreturns, and uncertainty in international trade, alsoemphasises the importance o arming systems that areresilient. It is vital or the industry to be adaptable so itremains pro table in years with low export returns aswell as maximising the opportunity in years with higherexport returns.

4. Emergence of New Imperativesfor Dairy Farming

The productivity and production goals established inthe original versions o the Strategic Framework orDairy Farmings Future were ambitious. The basis orthe target to increase productivity by 4% per annum

has already been discussed. This target was translatedinto component targets that included a 50% increasein production o dry matter per hectare over 10 years,as well as better conversion e ciencies. The re reshedFramework (2006) urther speci ed that the industryshould aim to increase total milksolids productionby 3% per annum. However, this heavy ocus onproductivity is now challenged.

There is a contradiction between ambitiousproduction and productivity goals andthe desire to reduce the environmental

ootprint o dairy armingThe dairy industrys production and productivity targetscreate a real tension with the heightened concernsover dairy armings environmental ootprint, and theconsequent regulatory controls being imposed on thedairy industry. The primary means or increasing dairyproduction, either by intensi cation or conversiono other land uses, both increase the environmental

ootprint or dairy arming. This is a undamentaldilemma or the industry.

Mixed record o compliance withenvironmental regulation, leading toincreased tension with government andother stakeholdersThe dairy arming industry has high levels o non-compliance in e fuent management, and this isincreasingly in the spotlight o public scrutiny. Forexample, Environment Canterburys 2008 report on itsmonitoring o resource consent compliance ound that20% o Canterbury dairy arms required re-inspectionvisits a ter incidents o signi cant or major non-compliance. It also ound that approximately a third o

arms had problems with e fuent discharge, o which17% were considered signi cant to major. Only 46%o dairy arms complied ully8. The result is a signi cant

increase in abatement notices and nes being issuedto dairy armers across New Zealand. This non-compliance is also being picked up by NGOs and otherinfuencers o public sentiment, with potentially negativeconsequences or the dairy industry.

Sensitive catchments including Taupo and Rotorua haveestablished guidelines limiting arming activity to lowernitrogen and also phosphorous discharges.

Increasing likelihood o urther constraintson use o resources such as water

Additional constraints around water access and costshould also be anticipated. In areas reliant on irrigationsuch as Canterbury, dairying aces pressure to increasewater use e ciency and limits to urther irrigation. In theWaikato, competition rom municipal and hydroelectricwater users may limit industry growth. It is instructivethat the main bene ciaries o the original Otago goldrush in the 19th century were not the gold miners,but those who owned the water rights. Similarly, inother parts o the world, cities and industrial users owater are competing with agriculture or scarce waterresources. Again, this suggests an environmental-economic constraint inconsistent with the dairyindustrys growth aspirations.

8 The compliance status o dairy shed e fuent discharges to land inthe Canterbury region or the 2007/08 season, ECAN Report,November 2008.

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The global ocus on greenhouse gases andemissions trading, with agriculture in thespotlight as a key culprit, means arming islikely to bear signifcant costsNew Zealand rati ed the Kyoto Protocol or theinternational Framework Convention on ClimateChange in 2002, however the implications o thatcommitment remained unclear or several years.The overall objective o this protocol is reducinggreenhouse gases (GHGs) in an e ort to preventanthropogenic 9 climate change. One o the primarymechanisms or achieving this end is economicincentives to reduce GHG emissions, which essentiallymeans a tax on those activities.

Agriculture has been identi ed as a signi cant producero GHGs, particularly methane rom ruminants,and hence targeted under New Zealands Kyotocommitments. The details o New Zealands EmissionsTrading Scheme (ETS) announced in 2008 indicate thatdairy armers will carry an additional cost o 3 cents perkg o milksolids in 2010, rising to 10 cents by 2013 and30 cents by 2025. Overall, reducing greenhouse gasemissions under the current ETS is likely to cost NewZealand dairy armers $500 million a year by 2025.

Other risks emerging or New Zealanddairy exports rom the dominance oglobal retail chains, and exposure to publicperception in oreign marketsThe control over market access is arguably shi ting

rom agreements between nation states to agreementsbetween producers and retailers. Global retailers areincredibly power ul in the market because they controlwhat products reach consumers in practically alldeveloped nations. This is both an opportunity and arisk or New Zealand. On the one hand, New Zealandexports much o its dairy products as ingredients, andso their risk is mitigated by good trading relationshipswith ood companies using those ingredients. On theother hand, the expectations o oreign consumersare increasingly likely to be a actor in determiningthe acceptability o New Zealand dairy products. Keyareas o risk include animal husbandry practices, andalso perceptions o the environmental impact o NewZealand dairy arming. The notion o ood miles whichemerged in 2005 and was promoted by British retailersand United States giant Walmart represents just one othe threats to New Zealand dair